Lynn Strongin Dodds looks at why risk managers are still struggling to build a robust risk management framework to mitigate the threats from an unexpected shock.
Given the recent wave of unexpected events, it may be surprising that global risk professionals are not more prepared for the unknown. Lessons do not seem to have been fully learnt although they have had plenty of practice over the past four years. They have not only had deal with the fall out from Covid but also ongoing geopolitical tensions, the US mini banking crisis, Liz Truss’ budget debacle and a shifting macroeconomic landscape.
These were the findings In a new report- Preparing for Financial Markets Shocks with Smarter Risk Management – from Coalition Greenwich which polled 46 risk professionals in the US, UK and Europe. They manage exposure to multiple asset classes at asset management firms, hedge funds, banks, and broker-dealers.
The report revealed that less than half of the respondents were confident in their risk management processes during normal market condition while just over a third were prepared to handle the next unanticipated market shock. It noted that risk management has become more problematic as markets today move faster and the list of threats grows ever longer.
Although significant, it is not just the sudden, sharp episodes that have confronted risk managers. The investment scene has also widened to incorporate a wider range of global strategies and new products that cater to investors changing preferences. In addition, trading has increasingly become more electronic especially for the more liquid asset classes such as equities and government bonds.
As a result, “in an era of real-time communications and increasing market volatility, overnight risk management might no longer be sufficient,” says Audrey Costabile, senior analyst for Coalition Greenwich Market Structure & Technology and author of the report.
She adds that “financial service firms are in a race to keep up with the increasing complexity, speed and scope of today’s global marketplace. Risk managers understand the stakes at play and are pushing for continued investment in faster and more accurate risk management technology.”
The report said that each asset class has its own idiosyncrasies, but overall data is the biggest pain point across the spectrum with 45% pointing to the inability to quickly access the requisite larger sets of good quality information from multiple internal and third-party systems. Meanwhile, almost 40% cannot get a single view of enterprise risk, particularly for more nuanced asset class exposures. This is because the data is often siloed and difficult to combine with some risk managers relying on multiple, disparate systems to view risk across all their books.
Drilling down to derivatives in particular, the biggest obstacles in descending order are running models of large data sets, data field reliability, data acquisition and normalisation.
Aside from data, building scenarios is seen as a significant obstacle due to the complexity and the inherent manual processes. Nearly three-quarters of participants are currently building scenarios to prepare for future shocks although a larger percentage – who are very confident in their risk management practices, at least in normal markets – are using stress tests to future-proof their investments and hedge against risk. The most popular are blanket simple, term-related and historical return shocks.
Given this disparate environment, having one system that could address all the issues would be the ideal, not to mention the most cost-effective system. However, the industry is a long way off achieving this goal due to the mix of legacy systems built over the years. Nearly half of respondents employ in-house systems which were likely built with a specific purpose in mind. Although data and functionality are controlled, they require staff to maintain the technology, including dealing with data, upgrades and the resiliency of the system, placing the burden of futureproofing on the firm.
The report also said that entrenched legacy biases often lead to the persistence of asset-class-specific risk technology silos—inhibiting interoperability and integration across different risk systems. Despite the availability of more adaptable third-party solutions, some professionals remain hesitant to transition due to familiarity with the status quo and perceived complications of integration. “Overcoming these entrenched biases requires a shift toward embracing modular, interoperable risk technologies that facilitate holistic risk management approaches,” the report noted.
When risk managers do turn to third-party providers, it is often to accommodate additional strategies, new products and new objectives. These firms typically offer SaaS, RaaS and other models that don’t require large infrastructure commitments and can offer some scale of knowledge, support and other services to meet the needs of the majority of clients. Although the flexibility is much needed, it comes with other challenges. As the report puts it, striking the balance between enough out-of-the-box features and complete modularity is difficult.
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